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Trade war: The US scores own goal

Trade war, US, European Union, US exports, America, global trade war, China, US trade, made in China, Chinese imports The typical character of all these industries are heavily decentralised value chains.

The year 2018 will be remembered for having witnessed the ‘trade war’. What begun on March 9, 2018, through the US announcement to increase tariffs on its steel and aluminium imports has now acquired a global character. With the US refusing to withdraw the tariff hikes, countries across the world, including America’s largest trade partners like the European Union and Canada, have reacted through retaliatory tariffs on US exports. The global trade war is likely to escalate with the US threatening to impose tariffs on automobiles and auto parts and components as well. Such tariffs, needless to say, would invite further retaliation.

The global shades of the trade war fail to mask a prominent bilateral strand within it. A major part of the tariffs being slapped back and forth involve the world’s two largest economies—the US and China. US trade actions have combined two aspects: global tariffs and China-specific actions. The latter include imposition of 25% tariffs targeted across more than 800 categories of goods ‘made in China’. The first part of these tariffs have become operational since June 6, 2018.

A Presidential statement issued on June 15, 2018, mentions such tariffs would eventually cover $50 billion of Chinese imports, suggesting tariffs on more imports are to follow. China has immediately reacted by increasing tariffs on an equivalent amount of US exports. If hostilities continue the way they are, and if US President Donald Trump lives up to his words, then tariffs might be imposed on ‘every single Chinese import into America’ to be probably followed by equivalent retaliation by China.

The US began the trade war for cutting the American economy’s dependence on imports and correcting trade imbalances with China and other major trade partners. Its actions are based on the assumption that higher tariffs would force American consumers to buy less imports. For China, it specifically expects the trade actions to encourage proactive policies from the government in changing ‘unfair’ trade and business practices that deny American businesses a level-playing field in mainland China. Whether the US will succeed will be revealed only by the future. In the meantime, however, the tariff battle can complicate business decisions across the world with significant ramifications for US businesses.

Many of the specific Chinese imports slapped with higher tariffs, particularly machinery and equipment, including critical medical equipment like cancer-detection systems, are manufactured by US businesses based in China. As these become more expensive, not only would American consumers be hurt, the profitability of US-based businesses in China would also decline. Lesser imports due to higher prices of US-business organised and manufactured ‘made in China’ products might bring down the US’s trade deficit with China on paper. But that will be at the expense of operating surpluses of US businesses. These lower surpluses would reduce repatriation of profits by American businesses back to the US.

Thus, what might be brought down through the goods trade account can actually be compensated by lesser inflows in capital account, leading to retention of deficit in the overall balance of payments. US business prospects might be damaged not just by its own tariffs, but also by tariffs hiked by China. A few weeks earlier, China responded to the US intention of raising tariffs on imports of automobiles and components by reducing its own tariffs on imported automobiles from 25% to 15%. But these lower tariffs won’t apply to US auto exports to China any more. Following China’s retaliation, US auto imports would now face higher tariffs of 40%. These would damage prospects of US auto exports in China at a time when they are also encountering higher retaliatory tariffs in Europe.

The US trade actions clearly don’t note the complexity of modern trade in terms of its decentralised organisation across various locations. Tariffs are ‘on the border’ trade barriers. Industries like automobiles, pharmaceuticals and chemicals have complex manufacturing processes. The typical character of all these industries are heavily decentralised value chains. Indeed, these are industries that have made ‘made in’ labels obsolete as it is almost impossible to identify from which country or geographical location the final products of these industries obtain maximum value from.

The final place of assembling for these industries could well be one of the locations of less value-added in the production network. Hitting a ‘made in China’ labelled item might actually end up inflicting more damage not on China, but on those countries that add more value to the item sold under the label, through supplies of raw materials, intermediates and various scale-based processing.

Countries with deep forward and backward linkages with global value chains might end up taking the worst hits as businesses work to diversify locations for avoiding tariff costs. These include several Asian countries, particularly from Southeast Asia. These were not intended to be the victims of the trade war. Ultimately, the futility of the trade spat is best borne out by the fact that it will hit those hardest which it didn’t intend to, including the US businesses.

The Author is Senior Research Fellow and Research Lead (Trade and Economic Policy) at the Institute of South Asian Studies in the National University of Singapore. Views are personal
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Source: Financial Express